Don’t Get Amazoned

I do not write about individual companies unless they can teach us something about the broader market like in GE: A Prelude .  So what can Amazon, the second most expensive company in the SP500, teach us about today’s market?

Fundamentals don’t matter today. 

But they will at some point.

Amazon goes parabolic

Amazon is up 500% in 3 1/2 years!

I love Amazon’s quick and easy service.  But Amazon’s stock is overpriced.  It’s the poster child for the whole US stock market.  Completely detached from fundamentals.

Let’s take a quick look:

Amazon is approaching 1 trillion in market cap.  Apple hit it first, but its numbers look better.  If you are a 1 trillion dollar company in a low margin mature business what should your Price-to-Earnings (PE) be?  Around 10-15.

A one trillion dollar company with a high PE of 15 would have 66 billion in profits annually!  A PE of ten requires 100 billion in profits.  So how close is Amazon?

If we annualized their 1st quarter results they will hit 6-7 billion this year.  So they only need to grow their profits by 1000% to hit a PE of 15.  The headlines never seem to mention this.  They simply swoon about how Amazon doubled its first quarter profits to 1.6 billion in the 1st quarter. This is not hard to do when you start with practically no profit margin.

Amazon’s sales hit 51 billion in the first quarter or 200 billion annualized. Growing sales rapidly in a low margin business is one thing.  Amazon in part achieved this high growth rate by subsiding you the customer with no profits on much of its retail business.

Achieving high profit margins like Apple in a low margin line of business is not going to happen. If they double their profit margin from 3.5% to 7%, then they still need to grow their revenue by 500% to a trillion in annual sales.  As a company becomes this large, the law of diminishing growth rates sets in and a PE of 15 makes sense.

So this means if Amazon’s price stops where it is, Amazon will only need to grow sales 500% while charging higher prices. Doable – yes.  How long will this take?  Probably not before the next recession or financial crisis sets in.

Use Amazon, but don’t get Amazoned.

At these prices it is no longer an investment, it is speculating. The same can be said for the stock market to a lesser degree.

And you really ought to read GE: A Prelude to understand why the next crisis will include pension funds.

Invest safe, invest smart.


TSP & Vanguard Smart Investor

Categories: Perspectives